Advantages & Disadvantages of Taking the Equity Out of Your Home

by Mike Parker

You can borrow against the equity in your home to do some remodeling.

Your home is not an investment in the purest sense of the word. It is, after all, your home. But homes have tended to increase in value over long periods of time, the recent housing crunch notwithstanding. As you continue making your monthly mortgage payments, you build up equity, or ownership in your home. That equity is like money in the bank that you can borrow at a highly competitive interest rate. Whether you should take the equity out of your home is a different matter.

Favorable Interest Rates

A home equity loan is secured by your home, so it acts as a second mortgage. Since you are using your home as collateral, the lender's risk is substantially reduced. The result is a loan or line of credit with significantly lower interest rates than are available from your credit card. You might use a low-interest home equity loan to pay off your high-interest debt and save some money.

Tax Break

The interest on most types of debt is not tax deductible, but mortgage interest is one notable exception. The Internal Revenue Service considers home equity loans to be mortgage loans, so not only do you get a low interest rate, in most cases you can deduct the amount of interest you pay each year when you file your federal income taxes. The best part: You don't have to use your home equity loan to pay for your home. You can use it for anything you wish, from taking a vacation to buying a boat.

Risking Your Home

Your home equity loan is secured by your home, the same as your first mortgage. If you fail to make your loan payments as agreed, the lender can take your home. If you decide to sell your home, you'll have to pay back the home equity loan out of the proceeds from the sale.

Considerations

When mortgage interest rates are at historic lows, you might be better off refinancing your home. You can still take the difference between what your home is worth and the amount you still owe on your original mortgage in cash. You will probably have to pay points and other loan origination fees to secure the refinance, but you will typically get a lower interest rate than is available for a home equity loan. You will have a single mortgage payment to make each month rather than two, and you will still maintain the benefits of tax-deductible mortgage interest.

Resources

About the Author

Mike Parker is a full-time writer, publisher and independent businessman. His background includes a career as an investments broker with such NYSE member firms as Edward Jones & Company, AG Edwards & Sons and Dean Witter. He helped launch DiscoverCard as one of the company's first merchant sales reps.